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Massachusetts Institute of Technology economics professor Peter A. Diamond smiles before the start of a news conference in Cambridge, Mass., after he won the 2010 Nobel Prize in economics along with Dale Mortensen and Christopher Pissarides on Monday Oct. 11, 2010. Mr. Diamond was not accepted as a board member for the Federal Reserve.

By the way, the Diamond nomination appeared doomed back in October of last year when Diamond had just won the Nobel Prize–as I wrote about at the time, here. The updated story on the “why” (from Diamond’s new column) isn’t really any different from the story last October.

Last October, I won the Nobel Prize in economics for my work on unemployment and the labor market. But I am unqualified to serve on the board of the Federal Reserve — at least according to the Republican senators who have blocked my nomination. How can this be?

The easy answer is to point to shortcomings in our confirmation process and to partisan polarization in Washington. The more troubling answer, though, points to a fundamental misunderstanding: a failure to recognize that analysis of unemployment is crucial to conducting monetary policy…

[U]nderstanding the labor market — and the process by which workers and jobs come together and separate — is critical to devising an effective monetary policy. The financial crisis has led to continuing high unemployment. The Fed has to properly assess the nature of that unemployment to be able to lower it as much as possible while avoiding inflation. If much of the unemployment is related to the business cycle — caused by a lack of adequate demand — the Fed can act to reduce it without touching off inflation. If instead the unemployment is primarily structural — caused by mismatches between the skills that companies need and the skills that workers have — aggressive Fed action to reduce it could be misguided.

In my Nobel acceptance speech in December, I discussed in detail the patterns of hiring in the American economy, and concluded that structural unemployment and issues of mismatch were not important in the slow recovery we have been experiencing, and thus not a reason to stop an accommodative monetary policy — a policy of keeping short-term interest rates exceptionally low and buying Treasury securities to keep long-term rates down. Analysis of the labor market is in fact central to monetary policy.

And what could a Nobel laureate economist bring to the question: what makes for better government? Towards the end of his column, Diamond suggests this:

To the public, the Washington debate is often about more versus less — in both spending and regulation. There is too little public awareness of the real consequences of some of these decisions. In reality, we need more spending on some programs and less spending on others, and we need more good regulations and fewer bad ones.

Analytical expertise is needed to accomplish this, to make government more effective and efficient. Skilled analytical thinking should not be drowned out by mistaken, ideologically driven views that more is always better or less is always better. I had hoped to bring some of my own expertise and experience to the Fed. Now I hope someone else can.

Enter Tim Pawlenty and his speech today, where he laid out his plan, summarized by: “Let’s grow the economy by 5%” (per year). His primary means of getting us there: revenue-losing-that-will-grow-the-economy-so-much-that-they’ll-become-revenue-gaining tax cuts. I’ll have much more to say about his tax reform plan later (and probably right up through the election). But besides cutting taxes, Pawlenty would cut spending–by what sounds like a lot. How would he figure out what to cut? He explains:

There’s some obvious targets. We can start by applying what I call “The Google Test.”

If you can find a good or service on the Internet. Then the federal government probably doesn’t need to be doing it.

So there’s Pawlenty’s answer (and the “connection” in this blog post). He’s basically saying: Who needs a Nobel laureate economist waxing philosophically and analytically on the spending we need more of versus the spending we need less of, when we could just “Google it.”

Huh?

If it’s not already obvious from my tone, I don’t like the “Google Test.” There are many things that the private sector cannot be expected to do well on its own, especially when an important “public good” is to provide a “safety net” for people who cannot fend for themselves. Or whenever any market participant faced with their own self-interest (to maximize their own individual utility or profit) would fail to account for the social costs or social benefits of his or her actions/decisions. The free market can only “optimize” based on market values; market forces (the “invisible hand”) can’t lead us to allocations that maximize social welfare where market prices don’t correlate well with social values.

I’ll be doing a Minnesota public radio interview on the Pawlenty speech tomorrow (Wednesday) morning, and if there’s anything to share afterward, I will post it.

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